Investment Principles

Investment strategies can vary widely, but they are usually built upon a solid foundation that is guided by a set of core principles. Here are some core principles to keep in mind as you plan out your own individual investment strategy.

Diversify Your Stock Holdings

Investment diversification involves spreading your investments across a wide array of asset classes, geographies and segments to help protect your portfolio from the effects of any one market trend, event or setback. The goal of diversification is to manage and reduce overall portfolio volatility. While it does not guarantee against losses, well-diversified investors often survive a downturn in the markets better than those who are not diversified. A well-diversified portfolio will usually include different types of asset classes, such as bonds and stocks, selected from various geographical markets, and how much of each will depend on the individual investor's investment horizon, risk tolerance and financial goals. The stocks portion of your portfolio should be well-diversified across various geographical regions, sectors and market capitalisations. Investing in different companies within the same industry does not provide you with adequate diversification, as an industry-wide downturn can negatively impact the overall performance of your portfolio. Similarly, you are also exposed to concentration risks even if you spread out your capital across companies in different industries, but all within the same geographical market.

Always Invest With A Margin Of Safety

Benjamin Graham once described the secret of sound investment in just three words – margin of safety. As intellectual as Graham was, the concept was simple to understand. Investing with a margin of safety involves the buying of a stock (or any other investments) when its market price is significantly below its intrinsic value. If an investor pays 50 cents for a stock that is worth $1, the 50% margin of safety minimises our odds of error, and reduces the amount of losses if the investment does not perform as initially expected. On the other hand, if the performance of the stock turns out to be within or even exceeding expectations, the investor stands to realise a high level of return on his investment. The key is to determine a price point at which the margin of safety is sufficient to justify a stock investment. While there is no universal definition of what constitutes an adequate margin of safety, a 15 – 20% discount to a stock's intrinsic value is typically deemed sufficient, while investors of riskier stocks (e.g. small cap companies) will usually demand a higher margin of safety of about 30 – 40%.

Develop A Suitable Asset Allocation Plan

By failing to plan, you are planning to fail. Investing without a plan is akin to cooking without a recipe. Just as how a recipe gives us detailed instructions on how to prepare a culinary dish, an investment plan gives us a clear road map on how we can achieve investment success, by identifying the investment instruments that are suited to our individual needs. This plan, typically known as the asset allocation plan, identifies the proportion of various assets (e.g. fixed income and stocks) that investors should have in their portfolios, based on the individual investor's investment horizon, risk tolerance and financial goals. Conservative investors will want to incorporate a significant weighting in fixed income, while investors with a greater appetite for risk may want to adopt a larger weighting in stocks. An asset allocation plan, coupled with periodic rebalancing, ensures that we capture market gains while staying diversified to minimise downside risks. More importantly, it helps us to remain focused on our goals.

Don't Let Your Emotions Get In The Way

While an asset allocation plan is one of the cornerstones of successful investing, having the emotional discipline to stick to it through varying market conditions is also equally important. In the short-term, financial markets can be extremely volatile with very obvious winners and losers. It is at such times that investors may feel tempted to alter their asset allocation plans in response to changing market conditions, either by chasing winners or selling losers, both of which can potentially impair the long-term performance of their portfolios. As long-term investors are more likely to gain from the tendency for the economy and share prices to grow over time, investors should not let short-term market noise dictate their emotions, or lead them in their investment decisions.

To reduce market risk and eliminate emotions from investment decisions, investors can consider adopting a dollar cost averaging strategy. The concept is straightforward – a fixed sum of money is invested each month, regardless of whether the market has risen or fallen. While a lump sum investment can potentially yield higher returns, a sustained market decline thereafter will wipe out a huge chunk of value from that lump sum investment. Dollar cost averaging, on the other hand, takes the guesswork and emotions away from our investment decisions, helping us to avoid the temptation of timing the market. During down markets, dollar cost averaging also allows investors to purchase increasing amounts at cheaper prices, which could translate to higher returns when markets eventually recover.

Consider Hands-Off Approach

Investing in the stock market can be time consuming, as investors need to perform research and analysis to find profitable stocks to invest in. For the time-starved, a 'hands-off approach' to investing might be warranted. One way to do this is through the use of exchange-traded funds (ETFs) to build a diversified portfolio. Investors only need to decide which geographical markets or sectors they want to invest in, how much to invest in each, and then utilise ETFs to put that plan in place. The advantage of using ETFs is that they are low-cost investment instruments, and the low costs are passed on to investors in the form of higher returns. However, ETFs simply track the performance of the market and are undeterred by expensive valuations. Another option that hands-off investors can consider is the actively-managed unit trusts. As active managers can be selective in the companies that they invest in, they can take advantage of market volatility to increase exposure to quality stocks at inexpensive valuations, something that ETFs are unable to do. The downside to unit trusts is that their management fees are typically higher than what an investor will find with an ETF.